Rate cuts don’t equal higher equities

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Lower interest rates should mean higher equities, but such neat relativities apply more to a long lost era of relatively discreet national economies. In a global context, where banks heavily depend on international funding and about two fifths of the ownership of the Australian stock market is from foreign institutions, it is far too simplistic. According to Deutsche bank, it is not a big deal for equities:

This easing cycle has so far taken 100bps off the RBA cash rate, but only~80bps off actual borrowing rates. In other easing cycles, rates were lowered by at least 200bps, and happened more quickly. Even taking into account households’ higher sensitivity to rates given high debt, this cycle is on the small side. And we don’t see much more to come (DB forecasts one more 25bp cut). Soft inflation has been driven by the rise in the AUD, while nontradables inflation has barely budged. And there’s still a multi-year capex boom for the economy to accommodate.

Perhaps the main effect might be an easing of the $A, if there is one. Home mortgage holders won’t get much relief and small and medium businesses will continue to get slugged. Deutsche notes that it is a fairly small rate cut compared with previous periods. And there are big question marks over the value in the stock market:

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It’s true that sectors such as discretionary retail and media are on very low PEs at present. But there has been significant compression of sector PEs of late, which means that the sectors on higher PEs are at less of a premium than high PE sectors in the past. We think it’s worth paying just a little bit more for sectors/stocks that actually have decent earnings prospects.

Deutsche reckons that unless the economy really deteriorates, there will not be many more interest rate cuts:

Although financial markets are currently priced for another 70bps of rate cuts over the next 6 months, we do not see the RBA cutting a lot more from here. It is true that underlying inflation is at the lower end of the target range, but this is largely the result of the rise in the AUD. As the AUD is unlikely to continue rising indefinitely, inflation seems more likely to pick up than fall. And, as the chart below shows, despite widespread talk about domestic economic weakness, inflation in non-tradable goods and services has barely moved from its average rate of ~4%.

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Maybe so, but significant economic weakness appears to be exactly where we are headed.
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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.